People kept their money at the goldsmith's. The goldsmith gave out receipts when he took in gold. People found it convenient to use the receipts for money, rather than trudging down to the goldsmith, exchanging receipts for gold, carrying the gold to market, and making their purchases. People found it convenient to use gold receipts for money, rather than the gold itself. Thus, paper money was born.
As gold receipts circulated more and more, goldsmiths found that they almost always had more gold on hand than they needed to cover incoming receipts. So they started lending out some of that excess gold. With gold on loan, goldsmiths had more receipts outstanding than they had gold in-house. Thus, fractional reserve banking was born.
Of course, the goldsmiths did not really have "excess" gold. They didn't have more than they needed to cover their outstanding receipts. They only had more than they needed at the moment.
And every once in a while there was a "panic" and a "run" on the bank, when everybody grabbed their gold receipts and went running down to the bank to get their gold, all at the same moment. That's when problems would arise with fractional reserve banking.
In days gone by there were two distinct kinds of money: one with intrinsic value, and one without. These days there are also two distinct kinds of money: one with interest charges, and one without. The extra cost of interest, or the absence of that cost, is the significant feature that distinguishes the two forms of money in our time.
Anyone can tell the difference between gold and paper. But who can tell the difference between a dollar issued by the Federal Reserve, free and clear, and a dollar loaned out by a bank at interest? The two look the same. Indeed they are the same in every way that matters, every way but one.
In every way but two, I guess:
1. Only one of them requires the payment of interest. And
2. The consequences of excess are different. When "free and clear" money becomes excessive, it creates "demand-pull" inflation. When "lent out at interest" money becomes excessive, it creates "cost-push" inflation.
To see the difference between money issued free and clear, and bank-money created and lent at interest, it is necessary to observe interest expense throughout the economy. Or to observe the use of credit. Or simply to observe the level of debt.
Most of us are well aware.
Distinguishing between the two types of money current today is a fundamental part of the Arthurian economics. All of our economic problems today emerge from imbalance between the two types of money.
In my "twelve pages" I used the primitive phrase "money-money" to mean money free and clear. I used "credit-money" to mean money created by lending at interest. This terminology is unsatisfactory.
"Credit-money" is ambiguous; "bank-money" is better. But then what name shall we use to represent money free and clear? "Federal Reserve money?" "Government money?" Those are worse than money-money!
In an attempt to improve my terminology, I will use the word issue to mean money issued by the Federal Reserve, and reissue to mean money lent at interest.
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